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Question 5: Financial Accounting and Financial Statement Analysis

(22 points)

Fridgee Inc. was established in the year 1990 with the main objective of establishing
commercially viable biotech processes with applications in medicine and the agricultural
industry. Over the last decade, the company has been a pioneer in fermentation
technology.
The company is going to merge with Stewart Inc. on the last day of 2006 and for this
purpose undertook a project to analyze Stewart's last few years financial statements. The
balance sheets of Stewart Inc. for the years 2004-2006 are as follows:

Balance sheet of Stewart Inc. as at 31 December (all figures in 000 CU Currency


Unit)
2004

2005

2006

Cash
Accounts receivable
Inventories
Held-to-maturity securities
Property, plant and equipment
Land

2,000
3,500
3,200
8,000
15,000
4,000

2,500
3,660
4,200
8,000
17,500
5,000

3,000
3,400
4,300
8,000
20,950
7,500

Total assets
Current liabilities
Long-term liabilities
Common stock
(10 CU par value)
Additional paid-in-capital
Retained earnings

35,700
2,500
4,000
9,000

40,860
4,000
4,000
10,000

47,150
3,000
4,000
10,000

9,000
11,200

10,000
12,860

10,000
20,150

Total liabilities and equity

35,700

40,860

47,150

a) From the financial statements of Stewart Inc. calculate the current ratio and the quick
ratio for the years 2005 and 2006.
(4 points)

The acquisition will take place with a single transaction; the exchange of common stock.
The shareholders of Stewart Inc. will receive 3 Fridgee shares (10 CU par value) for 2
Stewart shares. Immediately before the merger project was announced, the market price
of shares was:
- Fridgee share: 40 CU

- Stewart share: 50 CU.


Below is the balance sheet of Fridgee Inc. as at 31 December 2006 (all figures in 000
CU):
2006
Cash
Accounts receivable
Inventories
Held-to-maturity securities
Property, plant and equipment
Land

8,000
7,000
4,250
2,000
24,500
8,500

Total assets
Current liabilities
Long-term liabilities
Common stock
(10 CU par value)
Additional paid-in capital
Retained earnings

54,250
7,500
7,000
15,000

Total liabilities and equity

54,250

15,000
9,750

As at 31 December 2006, the fair values of assets and liabilities are (all figures in '000
CU):
Fridgee Inc.

Stewart Inc.

Cash
Accounts receivable
Inventories
Held-to-maturity securities
Property, plant and equipment
Land

8,000
7,000
4,600
2,000
30,000
10,000

3,000
3,400
5,000
10,000
30,000
10,000

Total assets

61,600

61,400

7,500
7,000

3,000
4,000

14,500

7,000

Current liabilities
Long-term liabilities
Total liabilities

b) Calculate goodwill resulting from the acquisition of Stewart Inc.

(6 points)

c) Applying the purchase method, prepare the balance sheet of the combined entity
below. [Hint: you have to fill the Combined entity column, the two empty columns
are at your disposal for calculations.]
(12 points)

[Add additional items if necessary]

Cash
Accounts receivable
Inventories
Held-to-maturity securities
Property, plant and equipment
Land

Total assets
Current liabilities
Long-term liabilities
Common stock
Additional paid-in capital
Retained earnings
Total liabilities and equity

Combined entity